Final answer:
Mr. Smith's purchase of a municipal bond at $105.00, when the face value is likely $100.00, means he bought it at a premium (c). When prevailing interest rates exceed a bond's return, its price drops making it possible for it to be sold at a discount to attract buyers. For a bond with a return below the market rate, investors will pay less than the face value, reflecting the newer higher rates.
Step-by-step explanation:
If Mr. Smith purchased a municipal bond at $105.00 per bond, and the face value of the bond is $100.00 (which is typically the case unless stated otherwise), then this bond was purchased at a premium. When a bond is purchased for more than its face value, it is said to be bought at a premium. Conversely, when a bond is purchased for less than its face value, it is said to be bought at a discount.
When answering question 2 about the risk of a bond, in a scenario where interest rates rise to 12%, but a bond is only offering 8% interest with one year to maturity, the price of the bond would be lowered to make it more attractive to investors. Due to the higher prevailing interest rates, the bond's price will drop below its par value, thus it will be sold at a discount to compensate the investor for the lower interest rate compared to the current market rate.
Regarding question 37, if the interest rates have risen to 9% but the bond in question only offers a 6% return, you would expect to pay less than the face value ($10,000) for this bond, as it is less attractive given the higher interest rates available in the market. The calculation of what you would actually be willing to pay for the bond would depend on the discounted present value of its cash flows at the new market interest rate of 9%.